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- [00:02]
A
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:20]
B
Hello and welcome everyone. I'm Mike Lyon, Founder and managing director of VistaPoint Advisors, and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Russell Perkins. Russell is the vice president at VistaPoint Advisors and he's been at VPA for over eight years. Russell was also in Growth Equity at Peak Span Capital. Russell spent a lot of time speaking to founders from both the advisory investment banking side and private equity investor perspectives. This gives him great insight on today's topic about generating and evaluating interest from PE firms. Please enjoy my conversation with Russell. Russell Founders get a ton of PE calls, particularly if you're between 15 to 20 employees. They typically hear from anywhere between 30 to 50 firms in a year. You're getting ready to have your first PE call. How do you get them excited and.
- [01:09]
C
What do you focus on as a founder or entrepreneur? I would initially focus on a couple things, product, market, opportunity and story. Implying a lot of interest is also something that's really helpful in building a competitive process if a PE or an investor or growth equity is interested. So strategic buyers are likely not far behind. But that's not always the other way around really thinking at the end of the day, an investor is trying to see if you as an entrepreneur seem backable, someone who's optimistic, reasonable and can deliver. And all these things are really important for any investor. Call now specifically to software framing as a high margin and recurring revenue business is super important. This isn't really the time or the place to share any sort of considerations or shortcomings of your business, but if those do come up, it's important to frame them as an opportunity. And another thing to keep in mind are the differences in what customers like to hear versus what investors like to hear. For example, things like customizability and pick your pricing may be great in a customer facing conversation, but not for investors who are worried about a lot of custom work that's being done for your customers. They typically want to hear things more like cheaply configurable instead of customizable and automated upselling instead of pick your pricing. Functionally these may mean similar things to you, but positioning wise they can be very different. We haven't really touched on anything data related yet, which we will a little bit later, but eventually you will need to show data to move the conversation along.
- [02:34]
B
I think a great point you made around what your customers want to hear versus maybe what investors want to hear. When you're talking to customers, they like to hear the words customer service and support. When investor hears that, that sounds expensive and low gross margin. You do have slightly different framing to the customers than the investors. And obviously as you mentioned, the data is going to back some of that stuff off. But I think a great point, they're different audiences and care about different things. So you're getting ready to go into this first call. What should you be looking out for? Obviously the investors are evaluating you, but you want to be evaluating the investors and whether you want to spend more time with them. Given you're going to hear from 40, 50, 60 of these firms, what are you on the lookout for on that first call?
- [03:13]
C
Even though you may feel that given the outreach, your role is to answer questions, this is an awesome opportunity for you to have some of your own questions answered before the call. I would try to look for a couple things on the investor's website, primarily sector focus, portfolio companies and team. Have they done any deals in my sector? Do they have any sort of content or thought pieces outlining their philosophy? Who are the team members focused on my vertical, how long have they been there, et cetera, et cetera. So obviously you're going to look into who you're speaking with, but we really feel that incentive structures for these calls can sometimes be a little bit different depending seniority levels. From a junior perspective, their incentive is to get stats to put into the database and those conversations are typically a little bit more one way, whereas senior calls are a bit more of a conversation focused on those second derivative things. Really just trying to get to the answer of are you backable if an information piece or what you're looking for is not on the firm's website, it's always helpful to ask. So a couple of things that are really important that we see oftentimes are investment criteria and how do I fit into that? What are the non negotiables from a metrics basis and how does the firm view the opportunity ahead within the vertical?
- [04:29]
B
One point I would just make Russell is not leading the investor too much. These guys are all really good at sales. So for example, if you say something like I would only do a minority deal, even though they might be thinking they want to do a majority transaction, they might kind of imply that they would do a minority deal. So I think it's good to ask some open ended questions and not lead the witness too much because all of these folks are good at sales and they'll kind of tell you what you want to hear a little bit to make it to the next round or be able to get more information. So after you've gotten over the flattery of taking a couple of these calls, you quickly realize, I can't spend my day, all day talking to investors. So you need to prioritize which calls to take. One of the mistakes we see founders make all the time is they either just respond to the ones that are the most persistent. So they get an email every few days or maybe have the best intro email, talk to us about what's a better way to prioritize which of these calls someone should take and shouldn't take.
- [05:20]
C
That's a really good point. I think as more and more firms are starting to leverage an outbound motion, figuring out where best to spend your time is super important. And initially we really recommend drilling that down to three to five firms. We think that that's a really good mix of both variability of opinions as well as time management on your side. You can do your own research, but definitely don't be afraid to leverage relationships at certain levels of growth, certain levels of metrics, certain levels of scale. We typically see investors split into three tiers, so premium, mid tier and more value based. And so based on some of our experiences and obviously others, there can be a really big difference between an investor that looks at software businesses as well as services businesses, as well as Internet businesses, versus a pure software buyer. They're going to be focused on different things. They may be comparing you versus other companies in their portfolio and other companies they're looking at. And that dynamic is really important to understand so you can take advantage of it.
- [06:17]
B
Great insight. And I think this is really important for founders because one of the frustrations we hear is they'll waste a lot of time with the wrong investors and they either get a skewed view of what's attractive in the market or what type of deal they could get done that doesn't really represent the broader market just because they haven't prioritized who they've been talking to. Well, so I think that's pretty important. And obviously reaching out to investment bankers, I mean, we have a great sense of who's a good fit and who's not. That's also another resource I would use. One thing to think about is how far you're willing to go on the first call. These investors are trying to get a lot of data and metrics out of you. To grade you, but I think you want to be thoughtful around how far you're going to go on this first call and what you're going to share. Russell, maybe talk us through a thought process for that and how you recommend founders think about that.
- [07:01]
C
You want to be brief here. Everyone thinks that they know many of the common metrics that investors will look for in their ideal company. We actually put together a couple podcast episodes on these metrics and benchmarking, but commonly we see investors look at top line revenue growth, retention and more recently profitability. I'd say the second layer down from these, which can often indicate a little bit more thoughtfulness behind the questions, includes things like market penetration, revenue composition, pipeline velocity and conversion, sales rep ramp and some of the other metrics and that sort. We really think that pre NDA you want to lean a little bit more towards market and product metrics versus financial numbers. If you can, if you must share financials, you can share historical, but definitely nothing forward looking financial. If you can, if you must, try to keep it very high level and think about the consistency of what you've shared from the future. Looking backwards to really start that cadence of whenever I talk to this person, they share a number and we know they're going to hit it. That sort of reliability is something that's really important that a lot of investors look at. And finally, I'd say one of the fallacies of the investor world is just getting a deal done quickly. But to do that, they're always going to need data. One of the biggest mistakes that we see is sharing off the shelf revenue by customer, as there's often some positioning or commentary that can be extremely valuable in positioning that data asset. And so sharing that prematurely is something that we definitely recommend getting a second opinion on if you're looking to do that with a interested party.
- [08:32]
B
Yeah, absolutely. And I know we've talked about this in other podcasts. Not giving a private equity investor the RBC data revenue by customer data upfront is key. You want to control the framing of retention, how you calculate it, what the results are, and then much later share the raw data for them to confirm it. Because if you just give them the raw data, they're going to come back with a really different analysis that implies a lower valuation. But I think that's all really important good advice as founders are thinking about heading into these calls and just not making a mistake upfront. One of the areas where I think founders waste a lot of time is they'll talk to an investor. That's a Great fit, seems like a good partner fit. But we just know that this investor is always a 30 to 40% discount. And I think sometimes founders are hesitant to ask that question around valuation and what are you going to pay? Talked about a way to maybe get at that so that you know you're not dealing with a value buyer. Some of the value buyers are particularly persuasive because that's what they have to lean on because they know they're going to be cheap. So they've developed other skills. Talk about a way for a founder to figure that out when they're talking with a private equity firm, if they haven't gotten 40 or 50 bids from this PE firm.
- [09:36]
C
I mean, you can always definitely try and ask directly. I think that always is worth a shot. But many firms are going to be a little bit ambiguous, so you can ask questions around it to try to get to the same answer. So things like what are best in class metrics for a company in my space, vertical size range, kind of whatever category you want to put yourself in. What are some of the trends and valuations we've seen more recently over the last six months versus last year versus the previous year? Maybe how another one of their portfolio companies within the same vertical was valued. They may be a little bit sensitive around that. But another way to say that question is my research shows X valuation as a generally accepted SaaS multiple. Whether that's from precedent transactions or we're seeing in the public market. How do you see our vertical comparing to that? Some of those things are just trying to get to the same answer in a different way. But I know a lot of investors really like talking about how they look at the world and that alignment is going to be really important should you decide to partner with them going forward. So I think that's a good way for you to get to know them better and them to get to know you a little bit better. But at the end of the day, if you want to bid, you're going to need to share information. If you want an evaluation without ever giving data, it's just never going to be fully informed. So if you get a bid and you haven't shared any information, we just really feel that that's hard to take as compelling. A lot of firms will use offers to get you into exclusivity and then figure out what you're worth later. And that doesn't always result in the optimum outcome for a lot of the parties that we've had experience with in the past.
- [11:07]
B
And we'll Oftentimes see, a founder's instinct is to negotiate price upfront before they give data. And while this sounds appealing, you know, I don't want to waste time if they can't get to a valuation, the reality is if they haven't seen all the data, the valuation they're giving you is not worth much. They're just kind of telling you what you want to hear. So definitely be on the lookout for that and try to avoid what seems like a potential shortcut. You should only really give folks data if you're interested in doing a transaction, and you shouldn't pay much attention to their evaluation if it's not fully informed. We kind of famously don't even pay a whole lot of attention to first round bids, right? Like obviously we rank them and prioritize them, but we don't think that's the end all be all in the process because they just don't know as much about the business. Private equity firms are increasingly focused on trying to get proprietary transactions done. That's where they deal directly with the founder and avoid a process. And really, when they avoid a process, what they're avoiding is competition with other buyers. So they're really good at selling this myth of a quick deal. Basically what they tell you is you can get a deal done quickly with them and avoid the months that it takes to get a traditional transaction done. This really isn't true because it takes a certain amount of time to get a transaction done and a lot of it's focused around diligence. Russell, talk a little bit about the myth of the quick deal, what they're selling there, and how to think about that as a founder.
- [12:23]
C
So this myth of a quick deal is really just a part of selling for many PE firms out there. Some investors are really big fans of waving a big number, getting into diligence, and then figuring out if they can stand behind it at a later date. These types of firms are really just trying to get into exclusivity and then figure out where the chips lie at the end of the day. But the key thing to remember is that there is no quick and easy deal. It's going to be the same amount of diligence work on your end. Any offer worth looking at is based on a lot of diligence, not only from a first party perspective, but also from a third party perspective. And so if you're interested in doing a deal, it really makes sense to explore all the options available, not just who's the most aggressive reaching out to you, or who is putting an offer in front of you.
- [13:08]
B
Great advice, Russell. So on today's podcast we talked a little bit about what to do to get investors excited, what you should be looking out for on the first call, what you want to share, what you want to take away from it, how to prioritize which of these calls you should take, how far is too far on the first call, how to talk about valuation and get a sense for Are they a value investor or would they pay a premium? And then this concept of the myth of a quick deal. Russell, thanks for joining us.
- [13:32]
C
Thanks, Mike.
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A
Disappoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and capital raised transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our Team team or check out the four Founders section of our site by visiting four Founders Guide.